Hurricane changes the game for Puerto Rico bond investors

NEW YORK (Reuters) - The impact of Hurricane Maria on Puerto Rico’s already shattered finances is changing the financial landscape as creditors rethink strategies two months after the storm, with many slashing positions and others settling in for a long wait.

Some investors had bet on strong recoveries for the island’s triple tax-exempt bonds after Puerto Rico declared bankruptcy on much of its debt in May. But that has become too long a play for some, with the path to financial solvency decidedly longer since Maria hit on Sept. 20, killing dozens, crippling infrastructure and spurring a population exodus.

According to court filings and a person close to the matter, hedge funds Stone Lion LP, Monarch Alternative Capital and Senator Investment Group have each shed between $254 million and $313 million in general obligation bonds.

A unit of mutual fund Franklin Templeton has sold about $294 million of general obligation (GO) debt, while hedge fund Varde Partners ditched roughly $136 million in so-called COFINA debt which is backed by Puerto Rico sales tax, the filings show.

At the same time, debt prices have plummeted. The benchmark GO bond, trading in default without a yield, changed hands at just under 60 U.S. cents on the dollar before the storm. On Tuesday it sank to an all-time low of 23.5 cents, according to Thomson Reuters. COFINA senior bonds dropped to 39.75 cents from 59.11 cents the day before Maria hit.

Puerto Rico was already in crisis when Maria smashed its shores. The bankrupt U.S. territory, whose finances the U.S. Congress placed under federal oversight, owed $120 billion in combined bond and pension debt. It had near-insolvent public health and retirement systems, and was suffering from a shrinking population.

Investors bet billions the island’s future could be salvaged through a blend of government reform and debt restructuring, but Maria blew away that calculation, causing tens of billions of dollars in estimated damage. The island’s government is seeking $94.4 billion in federal disaster recovery assistance.

The storm sparked a wave of emigration to the U.S. mainland that researchers at the nonprofit Climate Impact Lab say could lower Puerto Rican incomes by 21 percent over the next 15 years.

At the island’s current GDP growth rates, such a loss would take 26 years to recover, the researchers Solomon Hsiang and Trevor Houser found in a Sept. 29 report.

For investors, a new prevailing strategy is emerging - namely, that patience is a virtue, and delay is the name of the game.

“There’s no question the time frame has expanded,” said one creditor-side source. “Why absorb a loss at the weakest point?”

STOP OR GO?

At a public meeting on Oct. 31, the board directed Puerto Rico’s government to submit by Dec. 22 a revised fiscal turnaround plan, with fresh economic projections, to serve as the basis for restructuring talks.

Creditors privately accuse the board of trying to capitalize on the bonds’ low market value at investors’ expense.

Some analysts suggest creditors have good reason to be concerned. In an Oct. 31 report, Height Securities analyst Ed Groshans said a revised local budget could eliminate debt service altogether, leaving so-called growth bonds - whose repayment is contingent on future economic growth - as the only option.

ADVANTAGE COFINA?

One key dispute in Puerto Rico’s bankruptcy is over the priority of the island’s $18 billion in general obligation debt relative to its $17 billion in COFINA bonds.

Each class claims an ironclad right to Puerto Rico’s sales tax revenue. With sides locked in litigation, COFINA holders feel they may have an edge in the wake of Maria.

Due to the sell-off of GO bonds by some influential holders, an ad hoc negotiating group of GO creditors has seen its once sizeable $3.2 billion stockpile reduced by about a third.That decline could reduce their bargaining power in any future restructuring talks as newer holders of the debt might be more flexible in their positions.

“The sell-off of GO debt means new holders are getting in at a very low cost and with presumably lower recovery targets,“ said one COFINA creditor source. ”This will reduce the influence of litigious funds who opt to fight rather than pursue consensual solutions in good faith.”